• Cash is king. Absence of cash is death.
• Gross margin is good. More gross margin is better.
• Gross margin is the best source of growth capital.

Perhaps not explicitly stated, but implied, the value of your company is heavily influenced by:

• The quality of your earnings.
• The rate of growth of your earnings.

All of this leads us to focus on one particular aspect of your business – pricing. Considering how important it is, you might anticipate that I have sage advice for you. Surely with over thirty years in this arena, and having participated in hundreds of pricing decisions, I must know the answer.

I only wish that were so. What follow are some pricing decisions that didn’t quite work out as intended.

Case Study #1: The Inconsequential Add-On

An engineering software company developed and sold a package that added utility to the workstation for which it was intended. At the time, that fully loaded workstation cost about $35,000. We priced our product at $3,400.

The rationale for this was twofold.

First, we sold the product through value-added resellers (VARs), and we gave them a 60% margin on our product compared to the industry-standard at the time of 40%. An extra 20% of $3,400 was thought to be a pretty enticing incentive.

Second, by pricing the product at less than 10% of the system’s price, we believed that the VARS would be able to tack it on to a workstation order, with an “Oh, by the way, we suggest that you [the customer] add this product to the order. It doesn’t cost much compared to the system price, and you will get more than your money’s worth from its added functionality.”

Compelling logic. Severely flawed in the real world.

VARs want to close deals. VARs do not want to jeopardize a deal that can close, by trying to “nibble” a few more dollars from a customer. If a VAR can close on a $35,000 order, he will do so.

Also, VARs rarely (never?) do missionary sales. This is when something “new” is introduced to the market that requires nurturing and educating customers, with the time to close a sale measured in multiple months, if not years. At the risk of oversimplification (and the wrath of VARs everywhere), VARs like to take orders from existing customers. That immediately puts money in their pockets.

Case Study #2: When Is a Sale not a Sale?

Same company. Same conundrum. How do we motivate VARs to sell our product? Since there had been pushback on the price of $3,400, we decided we needed to increase the financial incentives for the VAR without actually lowering our MSRP, since we had deals in the pipeline at the stated price.

The answer? A limited-time six-for-five sale. We would give the VAR six products for the price of five, effectively a 17% discount. Also, we believed that if the VARs carried an inventory of our product, they would have additional incentive to sell it.

Again, compelling logic, and this time product began to move. Our sales were increasing on a month-to-month basis for four consecutive months. There were notable sighs of relief in the boardroom.

Then we started to notice an alarming trend. Our sales were growing, but our cash was declining, and upon inspection, accounts receivable (money our customers owed us) were increasing at an alarming rate.

What had happened was that the VARs saw a discount and took it, but had no intention of paying the invoices until they had sold the product to their customer (and in some cases, gotten paid by their customers). What we had counted as sales, the VARS looked at as consignments. In effect, we had created a rather expensive field-based inventory.

When this was all unraveled (and write-offs taken), less than 10% of the orders received during that time period were “real” orders. The remaining orders had been solely for the discount. While we were in the right legally, since the VARs were in clear violation of the terms of the sale, what were we to do? Sue our only customers? Not going to happen.

Case Study#3: Leaving Money on the Table

As you’ve seen, it’s pretty amazing how a bunch of relatively bright people, who have quite a bit at stake, can convince themselves of their collective brilliance, and be so wrong. I could continue along this path of self-flagellation, but I think you get the point, and dredging up these memories is starting to get painful for me.

I will now share a case study with you that started the same way, but had a much better outcome.

Establishing the initial price

Automated Healthcare was the pioneer in selling barcode-reading robots to hospital pharmacies. Since this was a new product in this space with few meaningful comparables from which to glean a reasonable pricing strategy, the management team had to make it up as it went along.

With that in mind, we had several objectives that at least helped us frame out thoughts. First, we would never sell a robot for less than what it cost us to make it. That meant that our alpha customers were going to have to agree to pay over $200,000 for something they’d never seen before, and that they knew was going to be a work-in-process, but I digress.

We also believed that the tipping point at which capital spending decisions in hospitals received intense scrutiny, and thus even longer selling cycles, was $500,000.

Further, we wanted to get $1 million of cash flow from each robot transaction over five years, and that provided guidance for pricing our maintenance contracts.

With those boundary conditions, we priced the two alpha products at $240,000 each. The initial beta product was priced at $320,000 and the last one, $430,000. The list price of the robot was established at $472,900. Maintenance was priced at slightly less than $10,000 a month.

Customers were willing to pay that (often with great reluctance, but pay they did, nonetheless). Our boundary conditions were met. We were happy and confident campers.

Changing the pricing strategy

About this time, we raised a significant amount of institutional venture capital in a round led by two out-of-town investors. They were much savvier about the ways of Wall Street than we (or so they claimed and we believed, at the time). They insisted that the large dollar value of our sales would likely make our quarter-to-quarter results relatively unpredictable, and that that profile would depress the valuation that the financial markets would give us at exit.

Therefore, Automated Healthcare shifted its entire pricing strategy to doing leases exclusively. While revenue would ramp up more slowly, and profitability on a GAAP accounting basis would be pushed back, this created a recurring revenue model that would have predictability and could support higher exit valuations.

Not wanting to get too far off track, the only way this could work is if a financial company were willing to buy our leases, so that we could get cash up front, even though we were recognizing the revenue over five years. Don’t let these details distract you.

We found such a finance company and we learned the art of crafting leasing deals that qualified for being purchased. How did we price the leases, you may ask? We took the $472,500 that we were getting from the sale of a robot, applied the various leasing company discounts, etc., and reverse-engineered a lease price that would yield us $494,000 in cash from the leasing company!

Note several things. We didn’t really pay much attention to our customers in doing all of this. We used the few data points of purchases at $472,500 to assume that an “equivalent” lease would be accepted. Second, we got more upfront cash out of the leases than we did when we sold the robots! [There were some short-term cash flow consequences of this abrupt shift in strategy, but that is another story for another time.]

Setting a new sales price

In fact, the leasing program was well received and we began taking orders on that basis. What we found, though, was that some hospitals needed a purchase option so that they could prove that the lease was the way to go. We pulled out our handy-dandy calculator, took our lease and calculated a sale price that clearly made the lease the preferred option. That price was $612,000, but we didn’t really care since we weren’t going to sell the robot anyway.

The revelation!

As many of you know, one of the appeals of the leasing option to a customer is that its expense can go through the normal operating budget and avoid the scrutiny of the capital spending approval process, staying below the radar screen so-to-speak. We found that some hospitals had found this practice running rampant and had prohibited leases.

When we approached these clients, we explained that we only did leases. They explained that they were only allowed to make capital equipment purchases. They asked for the price of our robot, and all we had to provide was that fictitious, reverse-engineered, ridiculous selling price of $612,000, since we “knew” that the sensible and supportable sales price was $472,900, based upon what we had been doing only months ago.

They bought the robot without batting an eye!

Where had we gone wrong? We had accepted the conventional wisdom that we needed to keep the price under $500,000 in order to get through the hospital’s purchase approval process. We never challenged that assumption. Shame on us! We were leaving at least $140,000 on the table!

With that insight and the superior execution of the Automated Healthcare team, the quality of our earnings made a significant contribution in justifying a $65 million price when the company was sold to McKesson in 1996.

Advice to entrepreneurs

• When establishing your price, talk to customers and others in the know to find out what “the traffic will bear.”
• If you need to sell through channels (like the VARs), my experience says that you need to focus your efforts in getting the end user to “pull” your product through the channel member.       In essence, you will need to do direct selling to prime the pump. Once the VAR is having some success (albeit because of your efforts), he will be much more likely to sell your product.
• Don’t get so enamored by the brilliance of your pricing strategy that you don’t get customer confirmation before you make a company-wide commitment to it.
• Always challenge conventional wisdom, accepted industry practices, and all other assumptions. Rarely are they as firm as you might first think.
• Gross margin is good.

The post Lessons Learned: Pricing first appeared on Innovation Works.

The post Lessons Learned: Pricing appeared first on Innovation Works.

Growth of these businesses is accomplished through opening new units. These are often called “cookie cutter” businesses; the proven formula is repeated time after time. Among the approaches to growth are:

• organic growth – one unit at a time as resources permit,
• chain of company-owned units – preplanned opening of multiple units, and
• franchising – preplanned system that enables others to own and operate units.

Each path is materially different from the others, and should be carefully chosen.

More on that later.

Template for Growth

Regardless of the growth strategy, in my opinion, the initial steps can be very similar:

• Open an initial unit;
• Open subsequent units to refine the formula; and
• Open units beyond that to prove that you can clone yourself.

Initial unit

Develop a strategy for business growth, get constructive criticism by those knowledgeable in the business, and launch the first unit. One of the primary purposes for this first unit is to find out what’s right and wrong with your plan.

If you’ve already had profit and loss responsibility for a unit of an existing chain (which I highly recommend), you are still likely to experience some surprises with the startup process, and you will definitely be challenged by cash flow management.

If you have never run a business like the one you are starting (as is often the case with restaurants and retail outlets), you will be on a steep learning curve. You are likely to be amazed by the differences between reality and your plan.

Concept refinement

Now that the real world has infiltrated your dream, you need to make the necessary adjustments and confirm their effectiveness. Depending upon many factors, it is possible (although unlikely) that a second unit is all that will be necessary.

The primary purpose of this step is to determine the “cookie’s recipe,” so to speak. What needs to be done so that a single unit will financially and operationally attractive.

Proof of concept

This is the critical step in the process. Your personal involvement in the prior steps will be a significant factor in their success. In order to grow, you will need to package the process and confirm that someone can be taught to do what you’ve done.

Among other things, during this step you will develop a training program and an operations manual. The manual will be a “cookbook” for starting and running a single unit. Creating this manual is not a trivial task. It needs to go into excruciating detail so that a unit manager can refer to it whenever she has a question.

Other infrastructure activities

In order to grow, you will need to put certain resources in place. Someone with experience will have to prepare the aforementioned operations manual and training program. These might be consultants, or people you hire. Someone has to do the training. Systems infrastructure will have to be selected and installed. The overall complexity of everything will stress your ability to manage it.

One of the critical skills that you will have to develop is that of site selection. “Location, location, location” will be a critical factor in the success of your operating units. You may be able to base your first few locations based upon your “gut,” but ultimately you will have to reduce it to a disciplined, data-based process.

Other activities depend on your growth strategy. Company-owned stores will require sophisticated financial management, for example. Franchising will require a franchisee solicitation marketing program, and people to implement it.

As I believe you have surmised, these steps require a great deal of effort, advanced planning, and resources (capital).

Each path is materially different from the others, and should be carefully chosen.

Franchising

Franchising is a business model and strategic decision, not a financing method. The first-time entrepreneur often misses this distinction.

The conventional wisdom goes something like this:

I’m going to start a franchise because I can grow my business with other people’s money. The franchisees will be responsible funding each outlet. That lets me grow quickly and reduces my risk. On top of that, the up-front franchise fee is all profit and will help cover some of my corporate overhead. To me, that’s obviously much more attractive, and more rewarding, than slowly building a chain of company-owned stores.

From the outside looking in, those are reasonable observations, but they are way off the mark.

First and foremost, if you choose the franchise structure, your business is selling franchises, not running a chain of restaurants [or whatever the self-contained economic unit is]. Before a franchisee is going to fund her outlet, she has to be convinced that she wants to buy a franchise, and of all the available franchises, yours is the right one for her.

You don’t franchise by hanging up a shingle. You’ve got to develop a marketing plan that brings you to the attention of potential franchisees. You’ve got to manage a sales process that converts the prospective franchisee into your franchisee.

• Where should you advertise (Wall Street Journal, Entrepreneur Magazine, social media)?
• Which trade shows and conferences should you attend? What kind of presence should you have? Do you need professional booth? How will you staff it?
• What should you include in your franchise kit? Who will design it?
• How do you close the deal?

This all takes time, money and staffing.

Oh, by the way, there’s got to be some substance to you as a company, as a credible franchisor. You need operations manuals; training programs and trainers; and site selection expertise and methodology, among other things. You need extensive legal work to properly establish your company’s ability to franchise, and to make sure you comply with the laws within any geographic area in which you want to sell a franchise.

You will need to find initial franchisees that are willing to make an extraordinary leap of faith to buy a franchise from you. You will need to meter your efforts because significant growth cannot be achieved until successful franchisees can be pointed to as models for what the prospective franchisee can become. Again, these take time, money and staffing.

About that franchise fee – if your franchisee solicitation program breaks even through the collection of those fees, you will be lucky.

Of course, all of this is for naught, unless your franchisees are successful over a long period of time. Again, the appearance of “free” money from franchise royalties is also a mirage. A good franchisor with successful franchisees will be spending a lot of money making its franchisees more successful. Franchisees really are expecting, and demand, services for their royalties, or they won’t renew their franchise agreements.

Franchising is not a panacea for growing a business rapidly. One set of challenges is being replaced by another.

Company-Owned Chain

As compared to franchising, building a chain of company-owned outlets is less complex and you have greater control. The offset is that the capital requirements are much greater and growth is likely to be slower.

Regarding control, you don’t really “control” a franchisee. Yes, they will sign a franchise agreement. Yes, that agreement proscribes certain ways that things will be done. BUT, there is no guarantee that the franchisee will comply to the letter of the agreement as you intended it.

Certainly, you can influence compliance by inspecting the franchisee and auditing its practices, but if they aren’t compliant, what can you do? You can turn your lawyers loose and maybe the conflict will be resolved in 3 years, but in the meantime, what has happened? Your other franchisees will certainly be aware of this battle between you and one of their peers. Time and money have been diverted.

Alternatively, with a company-owned facility, staffed by your employees, you can require performance of a certain type. Non-compliant employees will be terminated. Things will be done as you intend them or immediate action can be taken to rectify problems.

Financial Implications

As I hope you’ve seen, these are two entirely different businesses, that only share external traits, but are very different in terms of their actual operation. The funding requirements are also different.

Operating units

Each path has to have at least one company-owned operation at the beginning. Beyond that though, the next steps are situation-specific. Some franchisors have launched franchising after a single unit is up and operating. I wouldn’t recommend that, but it has been done.

For the company-owned chain to grow, investors have to be convinced that the individual economic unit generates the kind of cash flow that is appropriate to the investment and that the units can be replicated with success. Those issues may be resolved with only two outlets, but it’s likely to take more than that to remove sufficient risk that significant investment will be available on attractive returns.

The potential investor in a franchise will need to be convinced that you can predictably attract enough franchisees that the financial performance of the franchise system will yield the financial results that will lead to an attractive exit for that investor. In this case, you need to invent the cookie, implement it and then get others to buy the recipe and make their own cookie. What do you as franchisor need to do to get to that point, where growth capital is available, and available on acceptable terms?

Infrastructure

In the case of the company-owned chain, you can control the rate at which you build infrastructure, and its breadth and depth. You control rates of growth, and thereby cash requirements. The development of infrastructure will not be a primary driver in an investor’s perception of your risk. The people “at corporate” will play important roles, but they will be more supportive in nature. Success or failure will be measured by the success and failure of the operating units.

In a franchising environment, the corporate capabilities are what will determine success and failure. First, there will have to be a critical mass of people and capability so that you are viewed as a credible franchisor that can provide the necessary support and services that can attract franchisees. These capabilities must be available before you can get your first franchisee. You may be able to contract out some of these capabilities, but you’ll still have to oversee the contractor’s delivery of those services.

The previously mentioned marketing and sales plans for securing franchisees will need to be developed and proven to be replicable. The perceived risk of the franchise business centers on your ability to sell franchises.

Observations

Fund raising is a function of perceived risk and potential reward.

In my opinion, the initial investment in a company-owned chain will be viewed as less risky than franchising, from an investor’s perspective. The path to proving the business model is more direct and under your control. In a franchise, a large portion of the initial capital will go into infrastructure, and success is less easily measured.

Offsetting this is the knowledge that the overall capital requirements of a chain of company-owned outlets will ultimately dwarf those of a franchisor; the potential reward is likely to be perceived as lower as well.

Another benefit of the company-owned facility is that you will have several funding options. In some cases, it is possible to grow by funding each single outlet as a standalone enterprise. Investors can be sought for a single restaurant, for example. You might set up a limited partnership so that your company is the general partner and the investors will get some defined return on their investment. This has the benefit of isolating the amount of capital needed. It also preserves your equity in your business.

By the way, this is usually a transitional strategy until the perceived risk has been adequately reduced so that significant investment into your company, or conventional financing on reasonable terms, is available.

Organic Growth

Some people start businesses that have these characteristics as a lifestyle choice. They enjoy the business itself and they run it to achieve an acceptable level of income and a certain quality of life. Growth, or building a chain is not high on their priority list.

Still, when the first unit is a success, there’s inevitably an urge to do it again, and when that’s successful, do it one more time, and so on and so on. This needs to be done with forethought as well. Otherwise, you may end up in a place you never intended.

One of the reasons your first outlet is successful is because you are personally involved. If you open up other units, your efforts will be diluted over multiple outlets, and you will have to manage the people who are doing the job you used to do. Will those people bring the same passion and involvement to the business? Probably not.

In addition, the complexity of managing the entire business will increase as the square of the number of outlets (# of outlets²). While you may secure volume discounts from your vendors since you will be increasing your orders, the cash flow implications may be daunting. The size of your payables may rise to uncomfortable levels. Your vendor may be more aggressive in his collection procedures since you represent a larger liability to him.

If you try to run multiple businesses the same way you ran just one, it is highly likely that the wheels will come off the tracks. If you accommodate these new demands by adding people, you may be increasing overhead expenses without a corresponding improvement in margins.

If these things were to occur, your enjoyment of your job would decline; your income may fall, not rise; and the quality of your lifestyle may deteriorate. That’s not what you had in mind, is it.

Conclusion

None of these growth strategies is right or wrong. They are just inherently different, and are likely to lead to different destinations. These alternatives should be analyzed before one is selected. Thinking ahead can make all the difference.

The post “Cookie-Cutter” Businesses first appeared on Innovation Works.

The post “Cookie-Cutter” Businesses appeared first on Innovation Works.

99 out of 100 first-time entrepreneurs will respond that that’s ridiculous, and impossible. 99 out of 100 entrepreneurs who have multiple starts up under their belts will admit that it’s a challenge, but that it can be done, and is one of the most important exercises that an early stage business can undertake.

This concept, with many variations, is frequently found in books and articles about entrepreneurship. I call my particular flavor, The Declarative Imperative. It is similar to the Elevator Pitch, but even more demanding.

First Product Introduction

An early stage business often underestimates the cost of marketing its first product. It often takes far more time, effort, and money than anticipated. A common rule of thumb is that it will take twice as long and cost twice as much as an entrepreneur reflects in the commercialization plan.

An early stage company with cash constraints must create sales revenue quickly. Having an obvious and meaningful customer benefit, and being able to effectively communicate it, is essential to generating such sales.

The Declarative Imperative

An early stage company must be able to sell its product (or service) to a customer with one declarative sentence. The cost of selling increases dramatically with the length of a company’s marketing message.

Customer Interaction

Interaction with potential customers by an early stage business falls into three general categories: philosophy, education, and sales.

• The philosopher says, “Let me convince you why our approach is correct, regardless of how you currently operate.”
• The educator, on the other hand, proposes to the potential customer, “Let me explain how my product or service works,” often leaving it up to the customer to decide whether it has any applicability in his company.
• The salesman, though, says, “Buy my product to solve your problem.”

Challenges & Responses

What are some of the challenges for a startup company presented by the Declarative Imperative?

• Is the basic benefit to a customer simple and clear? While many subsidiary benefits may exist, is there an obvious one that cuts across all targeted customers?
• Can the benefit be quantified in a meaningful and effective way? Examples are increased sales, reduced cost of sales, higher production output, and reduced operating costs, either directly or through specific productivity improvements.
• Can you identify a segment of your anticipated customers who will immediately react to your proposed benefits more strongly than others?

This line of reasoning leads to several suggestions for first-time entrepreneurs:

• Focus your initial product design to deliver a few basic, important features and benefits to ease the sales burden. Doing one thing that customers will immediately value is often better than doing several things that complicate the message to your potential customers. In today’s jargon this is called the Minimum Viable Product (MVP).
• Even with this conservative approach, you will still make mistakes. Do not over-commit to the initial product configuration (or service) or a single marketing/sales strategy until you have gotten clear market confirmation of each in terms of a growing revenue stream. Another rule of thumb is that you don’t really know your business until you have at least five customers and three tell you the same thing about the benefits of your product.
• If “education” appears to be unavoidable, devote a great deal of energy to creating and evaluating alternatives. Is there another way to “slice and dice” your market? Should you put the product on the back burner and use your technology to deliver a service? Should you mothball your company until the market catches up with you and your vision?

The post Generating Sales Quickly & Cheaply first appeared on Innovation Works.

The post Generating Sales Quickly & Cheaply appeared first on Innovation Works.

By the way, what follows are my interpretations of my memories about two local companies with which I worked. I present them for illustrative purposes. It’s likely that there are factual errors, as well as different interpretations of these events by those who were involved.

Let’s start with The Declarative Imperative.

The Declarative Imperative

An early stage company must be able to sell its product (or service) to a customer with one declarative sentence. The cost of selling increases dramatically with the length of a company’s marketing message.

The Iconnex Philosophy

In the mid-1980s a British engineering society published a study that claimed that 85% of the life cycle costs of a product are committed within the first 5% of the design effort. The basic premise of Iconnex was that making those initial efforts more efficient would be of tremendous value to companies.

The Iconnex product, the Mechanical Engineering Workbench (MEW), integrated a drawing window, an equation solver (based upon parametric modeling), a spreadsheet and a word processor. The elegance of the product was astounding. Each of the functions was relatively immature and the Iconnex integration was truly an amazing achievement. Some of the challenges that Iconnex overcame included the absence of a graphical user interface in the operating system (DOS 3.0, I believe), the 640K-memory limitation, primitive (and expensive) graphics cards and color monitors.

At the time, conventional engineering practices limited the typical mechanical engineer to two or three design iterations before a design commitment was made. The Iconnex MEW enabled the engineer to go through 10 or more design iterations in the same amount of time. The compelling logic of our value proposition, and the elegance of our product, with a market potential of 414,000 practicing mechanical engineers, convinced us that we had a real winner. Thought leaders in the industry agreed.

Further confirmation was provided by the fact that another company, Aries, I believe, had received over $20 million of venture capital financing to develop a similar product, but on a mini-computer platform. (Yes, I know I am dating myself, but some history lessons are worth learning.) The Aries cost per seat was going to be $35,000. Ours was less than $3,500.

Long story, short, the company consumed over $6 million of cumulative venture capital financing (probably equivalent to about $20 million in today’s dollars) over several rounds; never figured out how to sell the product in sufficient volumes and with adequate predictability; and ultimately sold its source code for low six-figures.

The reason? We were in the philosophy business. We were telling people how they should do business. We were not responding to their “table pounding need” (I think I stole that phrase from Joel Adams of Adams Capital Management to give credit where credit is due). We had to spend a lot of time, energy and money trying to convince people that we were right (and, by implication, that they were wrong).

Iconnex did not satisfy The Declarative Imperative.

The NeuralWare Sales Machine

The most impressive example of accommodating The Declarative Imperative was conceived and implemented by the founders of NeuralWare.

NeuralWare was founded in the 1980s to take advantage of the confluence of factors that would allow the commercialization of neural networking technology. With Moore’s Law proving to be a real phenomenon, computing power and storage were rapidly approaching the price and performance that would make this practical. The vision of the founders was to develop a line of neural network products that could work on desktop computers.

Even today neural networks are not broadly known or widely used, so you can guess what it was like in the 1980s!

What follows may be more myth than fact, but it’s necessary context. In the late 1940s and early 1950s, as computers began to demonstrate their potential, two forms of artificial intelligence were conceived: expert systems and neural networks. Expert systems can be thought of as enormous decision trees that attempt to capture the variables and decision-making process of experts in certain domains. Neural networks mimic the learning process of the brain, recognizing patterns from within massive amounts of data and adjusting over time as it absorbs more and more data. Neural networks are used today in many applications including technical stock market analysis, credit card fraud detection, process control optimization and electronic fuel ignition, to name a few.

As computing power and programming sophistication improved, expert systems first, and neural networks second, became technically and commercially feasible. The Carnegie Group, an early Carnegie Mellon spinout, was one of four, I believe, prominent artificial intelligence companies based upon expert systems that was launched in the mid-1980s.

Returning to NeuralWare after that brief history lesson, you might think that its marketing challenge was even greater than that of Iconnex and even more philosophical in its market entry, but it wasn’t!

Why? Because the founders accepted certain realities and proceeded accordingly.

First, they didn’t have the resources to develop a deliverable product.

Second, they didn’t have the resources to mount a missionary sales and marketing campaign.

Third, while hundreds of thousands of engineers and programmers could use neural networks beneficially, by and large, they had no need to do so. They either didn’t know about neural networks; or knew about them, but didn’t know if they were applicable to their situation; and even if they were, how the heck did you build a neural network?!?!

BUT out of those hundreds of thousands of potential users, there were hundreds of people in research labs, in IT departments and in university labs who were aware of the potential of neural networks. They did monitor the environment to keep track of advancements in the field. They did believe that it was only a matter of time before neural networks would be able to deliver very significant benefits.

For these few hundred people, knowing about neural networks was important. They had a need. To that end, the first revenues for NeuralWare were from the sale of a bibliography of all articles and publications on neural networking that the founders had compiled as part of their initial research before launching the company!

Instead of philosophizing to the people who could use neural networking technology, NeuralWare went to the very small and very specific market niche of individuals who were already believers and thirsting for information.

The second revenue stream came from fees for seminars in Pittsburgh about neural networks that they marketed to the purchasers of the bibliography.

Most of the attendees from industry were at the seminars to assess the current or future applicability of neural networks within their companies. NeuralWare offered to do feasibility studies for a fee.

When the feasibility studies were completed, NeuralWare offered to develop a customized neural network system for those companies who wished to pay NeuralWare for that service.

Note the elegance of the company’s evolution. It SOLD products and services to people who had already been qualified as NEEDING them. The customers for the current deliverable became the target market for the next deliverable.

In the meantime, customers were paying NeuralWare to build the infrastructure and IP that it needed to develop the neural networking products that were their ultimate vision.

They recognized the power of The Declarative Imperative and used it to formulate a successful market entry strategy.

NeuralWare went on to be acquired by a firm out of Boston.

Advice to Entrepreneurs

• When you first start up your company, slice and dice your market opportunity until you can identify a group of specific customers who have an urgent current need for what only you can provide.
• Quite often going slowly at first is the best way to realize your ultimate dream.
• Heed the Declarative Imperative.

Iconnex Postscript

The prior anecdotes about Iconnex were slanted somewhat for illustrative purposes. Out of respect to the founders, investors and employees of Iconnex, I need to note that it was a noble effort that almost made it.

At one time, a major aircraft company had decided to standardize on the MEW across the corporation. They were about to issue an initial purchase order for 100 units (at a modest discount to the $3,500 unit price) and contract with Iconnex to develop client-server architecture. Between the credibility of this customer and the cash flow it would provide, this could have made the company.

As these agreements were working their way up the corporate ladder for approvals, elsewhere in the corporation, a decision was being made to decentralize purchasing, meaning there would not be any corporate-wide software standards. The 100-unit order by the corporation became a two-unit order by one division.

By the way, this is an example of Schwartz’ Law. What, you’ve never heard of Schwartz’ Law? Schwartz said that Murphy was an optimist!

Oh, yeah, I almost forgot.

Six months after Iconnex started, another company based upon parametric modeling was launched In Boston. Iconnex zigged. The other company zagged. That company was Parametric Technology (now PTC) and it has a current market valuation of over $6 billion.

Damn that Schwartz!

The post Selling, Educating & Philosophizing first appeared on Innovation Works.

The post Selling, Educating & Philosophizing appeared first on Innovation Works.

big market = big business

which in turn leads you to build your commercialization plan around penetrating a market potential of hundreds of millions, or even billions, of dollars. Sound familiar?

With that premise, you may make a declaration that looks something like this:

“By capturing 0.5% of the market, we will achieve our conservative sales forecasts. At the same time, we won’t be on the radar screens of the major players and won’t be subject to any competitive pressures.”

Red flags are raised! Alarm bells go off! Risk meter pegs out! Ding! Ding! Ding! Your business proposal goes into the wastebasket!

That was quick (perhaps less than 20 seconds). What happened?

INVESTOR REQUIREMENT #1: YOU’VE GOT TO KNOW YOUR MARKET

An investor will want to be comfortable that you understand the dynamics of your chosen market and that you can successfully build a business. How do you capture 0.5% of a market? If the investor were to provide you with the requested capital, what are the first three things you would do? Advertise? Hire a field sales force? How do you measure your progress?

The point I’m trying to make (and probably doing it poorly) is that a target of 0.5% market share tells an investor that you don’t really understand your market. It doesn’t give you the kind of focus that he knows you’ll need to be successful.

All of this adds up to risk that in the opinion of the potential investor may be enough to reject the investment opportunity without going any further.

INVESTOR REQUIREMENT #2: YOU’VE GOT TO HAVE A PRACTICAL BUSINESS DEVELOPMENT STRATEGY

You do need to build a case that your overall market is of a significant size so that you have an opportunity to build that big business that investors seek. You need “sex and sizzle” to attract the attention of the sophisticated investor. But once you’ve done that, you have to think small to get big. Let me explain.

Your challenge at this point is to determine meaningful market segmentation parameters so that the overall market can be divided into market segments. Next you have to define the niche within that segment that you will successfully penetrate because the members of that niche have specific needs that you can uniquely satisfy.

With beach head, you can describe how you will penetrate that niche deeper and deeper. You’ll also explain that you will pursue adjacent niches for which the entry and penetration activities will follow the pathway you used in the first niche.

Bear with me. I’ll walk through an example that I think will help you “get” this.

INVESTOR REQUIREMENT #3: YOU NEED A PLAN THAT YOU CAN EXECUTE

As noted above, a target of a market share of 0.5% doesn’t give you much help in conceiving of and developing a plan that you can execute. But, if you do a good job of identifying your niche, you can develop such a plan.

An investor will want you to be able to answer the following questions:

• Who are your immediate prospects, by name?
• Why is each likely to buy from you?
• What individuals in the prospect company will be involved in the purchase decision and what role will each play?
• How long will it take to receive a firm order?
• How many prospects will become customers in the first three, six, nine and twelve months?

You can answer these questions if you are focused on a niche. You can’t if you’re trying to get 0.5% of a market.

AN EXAMPLE: AUTOMATED HEALTHCARE, INC.

When I was a General Partner of the Pittsburgh Seed Fund, I was the lead investor in Automated Healthcare, a local startup that introduced robots to hospital pharmacies in the early 1990s.

Sean McDonald, founder and former CEO of Automated Healthcare, Inc. (AHI) and current CEO of Ocugenix, taught me these lessons. When I think back on those early days of the company, I marvel at his audacity and wonder how he ever convinced me to lead the investment in his company. In essence, Sean said, “I’m going to sell robots to hospitals for $1 million,” and I believed him!

In 1990 there were close to 4,000 hospitals in the United States (or so I recall, perhaps in error). That’s a pretty well-defined market, but not very useful. Of those, less than 1,000 had more than 400 beds, which meant that we believed that they were big enough to justify the use of a robot. And so, it went, until he had defined a universe of perhaps 25 hospitals that met the company’s requirements. Among those requirements were:

• Hospitals in which the director of pharmacy was an industry luminary, such as current and past presidents of the American Hospital Pharmacy Association (AHPA).
• Hospitals in which pharmacy directors would “get it” (the inherent benefits of automation and barcodes).
• Hospitals whose purchase of the AHI product would give AHI market credibility.
• Hospitals that would serve as references to other hospitals.

Among the company’s first ten customers were four of the past five presidents of the American Hospital Pharmacy Association. Now, that’s a niche! The company’s success with this initial batch of customers provided the foundation from which a broader market segment could be accessed.

By the way, this niche was wonderful for market entry and technical validation, but commercial success would be dependent on shifting gears. As such, AHI was a prime example of Moore’s Chasm Theory, but that’s a story for another day.

The company was sold to McKesson in 1996 for $65 million when its revenues were $7.5 million and was operating at a loss.

To get big, you have to think small.

Summary

• The identification of a large market is necessary to attract institutional investors.
• Identifying a niche is necessary to formulate an effective commercialization plan.
• You build your business one customer at a time.
• Initial customers need to enhance your ability to attract future customers.

The post To Get Big, You’ve Got To Think Small first appeared on Innovation Works.

The post To Get Big, You’ve Got To Think Small appeared first on Innovation Works.